Central bank tapering season is on the horizon: this means opportunities for price volatility, spread movements between products, and exchange rate fluctuations. It also means a potentially new set of market dynamics for liquidity and collateral supply across government bonds and other fixed income products.
Four major central banks have built up excess asset portfolios of US$10 trillion since the Global Financial Crisis, according to balance sheet changes before and after Quantitative Easing (QE) from the Federal Reserve, the European Central Bank, the Bank of England and the Bank of Japan. This large pool of assets has provided central banks the flexibility to engage in non-traditional economic policy making and stimulate their economies. It has also distorted markets worldwide. A move towards normalization will work to undo those distortions to one degree or another and will create new buying and selling patterns.
In this report, we evaluate the QE programs of large central banks, their successes in achieving target growth, unemployment and inflation rates, and their readiness to begin tapering off assets. We then assess what tapering may look like operationally and in theory, whether it is better to raise interest rates first and taper second, and what tapering timelines look like. Our primary focus is on liquidity and collateral. Will tapering help bond market liquidity or not? Will regulatory factors and tapering interplay for an entirely different supply/demand dynamic for collateral? While only some of these questions can be answered today, we provide a framework for thinking through a range of projected impacts.
This report should be read by capital markets professionals looking for an understanding of what tapering means for their business activities.
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